How climate change cools global trade
Every heatwave costs $360m in international exports and imports – and it will only get more costly unless we do something about it, says Oliver Schenker of Frankfurt School of Finance & Management
Climate change is having huge implications on our planet, there is no denying that. To stop this dangerous trajectory 196 countries pledged in the Paris Agreement, a legally binding international treaty, that they will limit global warming to well below 2, preferably 1.5 °C.
But how are things going? The world faces still increasing temperatures since the Paris Agreement entered into force in 2016. Nine of the last ten hottest years on record happened between 2013 and 2021. Experts of the International Energy Agency predict that with only the current measures in place, global temperatures will increase by 2.5 °C above preindustrial levels by the end of the century.
Understanding the exposure that economies have to a warming climate is thus necessary and important. Both, to develop adaptation measures and increase the resilience to these threats, and also to inform decision makers and voters about the consequences of insufficient action in reducing greenhouse gas emissions.
One important consequence of global warming is heat stress. Many previous studies have looked at the impact of heatwaves and other extreme weather events on local economies. But economies are not isolated from each other. As international trade links the fortune of economies, the economic impacts of local extreme weather events may spill over and disseminate through the global trade network. The impact of heat waves on global trade and their transmission through the trade network is what we wanted to understand.
Understanding the bigger picture
Our research, jointly with Daniel Osberghaus from ZEW Mannheim, hoped to answer, first, do heatwaves affect exports? Second, if so, through which channels do these events affect bilateral trade and which characteristics govern the effects? And third, what is the spatial distribution of the costs of these events and how much of these costs arise in not directly exposed countries?
We collected over five decades of monthly bilateral trade and weather data; in total more than 3.8 million observations. We found that the average heatwave causes significant global costs, some $360m in lost international trade. About two-thirds of these costs appear in countries not directly exposed to the temperature event, suggesting that substantial parts of the costs of these shocks are transmitted and propagated through the trade network.
In a month when the average temperature is at least 30°C, exports decrease by 3.4% relative to a month with an average temperature below this threshold. Using an alternative specification of extreme deviations from country-specific mean temperatures, we find that a top-percentile temperature shock in the export country reduces the export value by 2.1%.
These extreme heatwaves cause labour productivity to drastically fall. This is also what we found in our data: the more labour-intensive the exports of a country are, the stronger is the reduction in exports in case of a heatwave.
Those countries looking to import from countries that are experiencing heatwaves have two options when supply drops. They either have to pay a higher cost, whether that be from the current exporter experiencing lower supply, or they have to go elsewhere and face additional costs too. Or, they have to accept the losses, meaning a lack of supply and sales in their own countries.
And it is only going to become more costly globally unless we do something to reduce the impact of rising temperatures. By analysing the magnitude of these spillovers under two-year climate temperature projections, we found that in a conservative projection of the period 2020 to 2039, annual global trade is reduced by about $735m due to additional high temperature events – a significant loss for countries alongside the crueller impacts that heatwaves can cause for health and wellbeing.
So, how can we ensure that the global trade networks are not adversely impacted by extreme weather incidents in one country? Well, a first reaction might be suggesting that countries should become more protectionist in their trade policies in order to shield themselves from these spillovers – but that simply does not work. In fact, on the contrary, it is global trade with its substitution possibilities that reduces the economic losses caused by climate change.
We need, of course, much more stringent collective global action to reduce the emission of greenhouse gases. But we must also improve infrastructure and become more resilient to more frequent and severe heatwaves. Our research shows that the adaptation to climate change is not only a local issue but that strengthening the resilience of global supply chains is beneficial also for countries and businesses with less direct exposure to climate change and its extreme events.
ABOUT THE AUTHOR
Oliver Schenker is a Professor of Environmental Economics at Frankfurt School of Finance & Management. His research focuses on climate impacts and policies. This research project was conducted with Dr Daniel Osberghaus, Senior Researcher at the ZEW Mannheim Research Unit, Environmental and Climate Economics.